Detroit Bankruptcy Casts Shadow Over Muni Bond ETFs

December 9th at 2:57pm by Max Chen

Last week, a judge declared bankrupt Detroit is eligible for protection from creditors, potentially leaving municipal bond holders in a lurch. However, muni exchange traded fund investors have another option available.

On December third, Judge Steven Rhodes ruled that Detroit is eligible for protection from its creditors after the city filed for Chapter 9 Bankruptcy, The Economist reports. Rhodes’s has also made clear that bondholders and pension-holders alike will expect to take a hit.

“What you really hope something like this does will lead the unions to recognize that there is a chance that their benefits could be cut back in bankruptcy and they’re better off working with these cities now to share in the pain,” David Crane, a one-time economic adviser to former California Governor Arnold Schwarzenegger on pension issues, said in a Bloomberg article.

However, Rhodes did not address the issue of whether or not general-obligation bonds are considered unsecured debt. Moody’s ratings agency, though, believes that risks to bondholders are implicit to the judge’s ruling, which means everyone is on the hook.

Many of the largest muni bond ETFs, such as the iShares S&P National AMT-Free Muni Bond ETF (NYSEArca: MUB) and the SPDR Nuveen Barclays Municipal Bond ETF (NYSEArca: TFI), are heavily allocated to general obligation (GO) bonds, or bonds that are backed by the credit and taxing ability of a city or state. [Advisors Like the New Spin on Muni Bond ETFs]

Looking ahead, observers are growing increasingly concerned about Chicago’s finances. The city has more general-obligation debt per person than any of the ten largest cities, except New York.

On the other hand, investors can take a look at the db X-Trackers Municipal Infrastructure Revenue Bond Fund (NYSEArca: RVNU), the first ETF to focus exclusively on revenue bonds, or those munis that are supported by revenue from projects such as toll roads or bridges.

Revenue bonds skirt pension risk, meaning RVNU offers investors the income and conservative posture they’re accustomed to with muni ETFs without the fears of capital loss at the hands of increasing muni bankruptcies. [A Muni Bond ETF that Sidesteps Default Worries]

For more information on the munis market, visit our  municipal bonds category.